Figure 12.5 describes a process for identifying the best alternative from a set of mutually exclusive alternatives. Decision criteria depend on the business objectives and typically include ROI (see section 4.3, Return on Investment) or Return on Capital Employed (ROCE) (see section 4.4, Return on Capital Employed).
For-Profit Decision Analysis
For-profit decision techniques don’t apply for government and nonprofit organizations. In these cases, organizations have different goals—which means that a different set of decision techniques are needed, such as cost-benefit or cost-effectiveness analysis.
Minimum Acceptable Rate of Return
The minimum acceptable rate of return (MARR) is the lowest internal rate of return the organization would consider to be a good investment. Generally speaking, it wouldn’t be smart to invest in an activity with a return of 10% when there’s another activity that’s known to return 20%. The MARR is a statement that an organization is confident it can achieve at least that rate of return. The MARR represents the organization’s opportunity cost for investments. By choosing to invest in some activity, the organization is explicitly deciding to not invest that same money somewhere else. If the organization is already confident it can get some known rate of return, other alternatives should be chosen only if their rate of return is at least that high. A simple way to account for that opportunity cost is to use the MARR as the interest rate in business decisions. An alternative’s present worth evaluated at the MARR shows how much more or less (in present-day cash terms) that alternative is worth than investing at the MARR.
Return on Investment
Return on investment (ROI) is a measure of the profitability of a company or business unit. It is defined as the ratio of money gained or lost (whether realized or unrealized) on an investment relative to the amount of money invested. The purpose of ROI varies and includes, for instance, providing a rationale for future investments and acquisition decisions.
Return on Capital Employed
The return on capital employed (ROCE) is a measure of the profitability of a company or business unit. It is defined as the ratio of a gross profit before taxes and interest (EBIT) to the total assets minus current liabilities. It describes the return on the used capital.
Cost-Benefit Analysis
Cost-benefit analysis is one of the most widely used methods for evaluating individual proposals. Any proposal with a benefit-cost ratio of less than 1.0 can usually be rejected without further analysis because it would cost more than the benefit. Proposals with a higher ratio need to consider the associated risk of an investment and compare the benefits with the option of investing the money at a guaranteed interest rate (see section 4.2, Minimum Acceptable Rate of Return).
Cost-Effectiveness Analysis
Cost-effectiveness analysis is similar to costbenefit analysis. There are two versions of costeffectiveness analysis: the fixed-cost version maximizes the benefit given some upper bound on cost; the fixed-effectiveness version minimizes the cost needed to achieve a fixed goal.
Break-Even Analysis
Break-even analysis identifies the point where the costs of developing a product and the revenue to be generated are equal. Such an analysis can be used to choose between different proposals at different estimated costs and revenue. Given estimated costs and revenue of two or more proposals, break-even analysis helps in choosing among them.
Business Case
The business case is the consolidated information summarizing and explaining a business proposal from different perspectives for a decision maker (cost, benefit, risk, and so on). It is often used to assess the potential value of a product, which can be used as a basis in the investment decisionmaking process. As opposed to a mere profitloss calculation, the business case is a “case” of plans and analyses that is owned by the product manager and used in support of achieving the business objectives.
Multiple Attribute Evaluation
The topics discussed so far are used to make decisions based on a single decision criterion: money. The alternative with the best present worth, the best ROI, and so forth is the one selected. Aside from technical feasibility, money is almost always the most important decision criterion, but it’s not always the only one. Quite often there are other criteria, other “attributes,” that need to be considered, and those attributes can’t be cast in terms of money. Multiple attribute decision techniques allow other, nonfinancial criteria to be factored into the decision.
There are two families of multiple attribute decision techniques that differ in how they use the attributes in the decision. One family is the “compensatory,” or single-dimensioned, techniques. This family collapses all of the attributes onto a single figure of merit. The family is called compensatory because, for any given alternative, a lower score in one attribute can be compensated by—or traded off against—a higher score in other attributes. The compensatory techniques include
• nondimensional scaling
• additive weighting
• analytic hierarchy process
In contrast, the other family is the “noncompensatory,” or fully dimensioned, techniques. This family does not allow tradeoffs among the attributes. Each attribute is treated as a separate entity in the decision process. The noncompensatory techniques include
• dominance
• satisficing
• lexicography
Optimization Analysis
The typical use of optimization analysis is to study a cost function over a range of values to find the point where overall performance is best. Software’s classic space-time tradeoff is an example of optimization; an algorithm that runs faster will often use more memory. Optimization balances the value of the faster runtime against the cost of the additional memory.
Real options analysis can be used to quantify the value of project choices, including the value of delaying a decision. Such options are difficult to compute with precision. However, awareness that choices have a monetary value provides insight in the timing of decisions such as increasing project staff or lengthening time to market to improve quality.
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Published on : 30-May-2018
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